GARP SCR Chapter 5: Aspirant asked questions

 Question based on Chapter 05

In this post, below questions have been answered:

Q1. How are green bonds regulated as the involvement of external verification by the bond issuer is not compulsory? How are the bond holders assured if the green bond issuer is correctly managing the proceeds as was promised? 

Q2.For Sustainable finance, Why Economic and Governance sub-types are mentioned in addition to E,S and G sub-types?

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Question #1:

 Questions asked by LinkedIn community member Chris Moutzouris

How are green bonds regulated as the involvement of external verification by the bond issuer is not compulsory? How are the bond holders assured if the green bond issuer is correctly managing the proceeds as was promised? 

ANSWER: 

Here is the explanation:

While external review for green bonds is optional and internal auditing is managed by the issuing company, several regulatory mechanisms and market practices help ensure that companies comply with their commitments and maintain transparency.

 Regulatory Oversight and Market Practices

1. Regulatory Frameworks

   - National Regulations: Some countries have specific regulations and guidelines for green bonds. For example, China and the EU have developed frameworks that include mandatory disclosure requirements and external review recommendations.

   - Securities Regulators: Securities regulators in various jurisdictions may oversee green bond issuances to ensure compliance with general securities laws, including disclosure and transparency requirements.

2. Market Standards and Guidelines

   - Green Bond Principles (GBP): Although voluntary, the GBP established by the International Capital Market Association (ICMA) set best practices for transparency, disclosure, and reporting. Companies that follow these principles are more likely to gain investor trust.

   - Climate Bonds Standard (CBS): The Climate Bonds Initiative (CBI) provides certification based on rigorous standards. Companies that seek certification must adhere to strict criteria and reporting requirements, which include external review.

3. Investor Pressure and Market Demand

   - Reputation Risk: Issuing a green bond without transparency or failing to meet commitments can damage a company's reputation, leading to loss of investor trust and potential financial consequences.

   - Demand for Transparency: Investors increasingly demand detailed information and transparency. Companies that fail to provide this may struggle to attract investment for future bond issuances.

4. Third-Party Verification and Rating Agencies

   - Independent Reviews: Even though external verification is optional, many investors prefer bonds with second-party opinions, third-party verifications, or certifications from entities like the Climate Bonds Initiative (CBI).

   - ESG Ratings: Rating agencies such as MSCI, Sustainalytics, and others evaluate companies' ESG performance, including their green bond practices. Poor ratings can impact a company's ability to raise funds.

5. Disclosure Requirements

   - Annual Reporting: Companies are generally expected to provide annual reports on the use of proceeds and the environmental impact of the projects funded by the green bond. This is a key aspect of transparency and accountability.

   - Impact Reporting: Detailed impact reports help investors assess whether the funds are being used as promised. These reports often include metrics on environmental benefits such as CO2 emissions reduced or renewable energy generated.

Example: European Union’s Sustainable Finance Disclosure Regulation (SFDR)

The EU’s SFDR mandates financial market participants and advisors to disclose how they consider ESG factors in their investment decisions and advice. This includes specific disclosures for green bonds, aiming to increase transparency and prevent greenwashing.

Case Studies of Regulatory and Market Oversight

1. China’s Green Bond Guidelines: The People’s Bank of China and the National Development and Reform Commission have issued guidelines requiring specific disclosures for green bonds. These guidelines also recommend, but do not mandate, external reviews.

2. EU Green Bond Standard (EUGBS): The proposed EUGBS includes mandatory external verification of green bonds and alignment with the EU taxonomy for sustainable activities, which will further enhance transparency and investor confidence.

By adhering to these guidelines and mechanisms, companies can build trust with investors and stakeholders, ensuring that the proceeds from green bonds are managed and used as promised, even in the absence of mandatory external verification. Similar mechanisms are existing for other green finance instruments that are following voluntary standards.

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Question #2:

 Questions asked by LinkedIn community member Chris Moutzouris

For Sustainable finance, Why Economic and Governance sub-types are mentioned in addition to E,S and G sub-types?

ANSWER:

In sustainable finance, while social bonds focus on promoting social impacts and climate finance targets climate-related objectives, there are indeed financial instruments and strategies that address governance and economic factors. These instruments aim to promote good governance practices and support sustainable economic development. Here are some examples:

 Governance-focused Finance:

1. Governance Bonds (G-Bonds):
 

Definition: Bonds issued to finance projects that aim to improve governance structures and practices within organizations, public institutions, or governments.

Objectives:
     - Enhance transparency and accountability.
     - Strengthen legal and regulatory frameworks.
     - Promote anti-corruption measures.
     - Improve corporate governance standards.
   

Examples:
     - Bonds issued to fund anti-corruption initiatives.
     - Bonds to support the development of robust legal and regulatory systems.

2. Sustainability-Linked Bonds (SLBs):
Definition: 

Bonds where the financial and/or structural characteristics can vary depending on whether the issuer achieves predefined sustainability or ESG objectives, including governance goals.

Objectives:
     - Encourage issuers to meet specific governance targets, such as improving board diversity, enhancing transparency, or implementing robust risk management systems.
 

Examples:
 Bonds that adjust interest rates based on the issuer's achievement of specific governance-related Key Performance Indicators (KPIs).

Economic-focused Finance:

1. Development Bonds:
   Definition: Bonds issued to finance projects that support sustainable economic development in emerging and developing markets.
   

    Objectives:
     - Promote economic growth and stability.
     - Develop infrastructure.
     - Improve education and healthcare systems.
     - Reduce poverty and inequality.
   

  Examples:
     - Bonds issued by development banks (e.g., World Bank, African Development Bank) to fund infrastructure projects in developing countries.

2. Impact Investing:
   Definition: 

 Investments made with the intention to generate positive, measurable social and environmental impacts alongside a financial return.
   Objectives:
     - Support economic development projects that create jobs and stimulate economic growth.
     - Invest in businesses and initiatives that address social and environmental challenges.
   

  Examples:

     - Investments in education and healthcare projects that promote economic stability and growth.


While governance and economic factors may not have as many dedicated financial instruments as social or climate finance, they are increasingly being integrated into broader sustainable finance strategies. Instruments like governance bonds, development bonds, and sustainability-linked bonds.These approaches help create a holistic framework for achieving long-term sustainability goals across various dimensions.

Hope it helps!

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